Options 101, Thursday, 02/27/2003

Gold Reality vs. Media Myth

by Buzz Lynn

I live for the day that investors blow up their television in
unison having become disgusted with the idiocies uttered in the
name of journalism. I will also probably die with that dream
unfulfilled.

Be that as it may, I'm on a rant today about the completely false
premise that Iraqi war jitters are the cause of gold's rise in
recent months. Makes me want to revert back to the days when I'd
"mute" the volume on CNBC, as I watched parades of analysts talk
about compelling values, great buys, market bottoms, and last
chances to buy stocks while the train was leaving the station -
for the last three years, and so far, this year too.

Come to think of it, the train never left the station and
thankfully, I still have a "mute" button! Honestly, the War with
Iraq has been the explanation de jour for the market's movements
either up or down, and I say that for both equities AND gold.
There are no shortage of talking heads noting that, "Fears of war
sent the market tumbling today", or "Iraq is deciding whether it
will dismantle its missiles this weekend, which helped the markets
close sharply up today", or some other such flimsy explanation
that begins with, "In the war on terrorism today, . . . "

Talking Heads, please forgive me for this public service
announcement, however, this is a bear market! Equity values
decline in general. Bear market rallies always suck in bulls who
still want to believe in the magic of Free Money From Greenspan.
Undesirable outcomes, often unforeseen, happen. It is the nature
of the bear.

It is also the nature of humans everywhere to find, right or
wrong, an answer to every question we have. Since we are
collectively asking, "Why did the market move today?", those "in
the know" (who really know no more than any of us in the trenches)
are searching for a sound bite answer rather than devoting a
segment to education. Today, we dispense with the sound bites,
and as Jethro Bodine of Beverly Hillbilly's fame would say, "Let's
commence to educatin'!"

Please note that I am not infallible, nor am I a guru. The
trouble is that gurus are wrong eventually, and I will be wrong on
many occasions, as I have been in the past. I hope I never attain
the status of guru. For I would know then that my reputation and
integrity will soon be destroyed. And that is too valuable to
risk. But back to Professor Bodine. . .

Myth

Gold is also presumed to be rising and falling on investors' moods
regarding an Iraqi war and the War on Terror. When uncertainty is
thought to eventually lead to conflict, common wisdom is that
'fraidy cats and the delusionally paranoid will buy gold, and that
that must be the reason we've seen the price rise in recent
months. Similarly, common wisdom also states that when war
jitters ease, the paranoid leave their mountain huts and revert
back to a diet of speculative stocks and 110% equity financing to
assimilate with society. Gold is for kooks.

What we often hear in the press are references to "barbarous
relic", thing of the past, gold fever, currency of the wacked-out
hermits, etc. The presumption is that when the war is won quickly
and easily, gold will be recognized as a sideshow, uncertainty
will end, and gold will sell off. No longer in need of protection
from uncertainty, we are cautioned now about the probable sell-off
once the nerves of a nation on the brink are calmed, and
terrorists are brought to justice.

In short, the thinking is that gold prices are in an Iraqi war/War
on Terror bull market, and the bull will die when the war is over.
I disagree with both premises. In fact, I would postulate, as
have many smarter than me, that gold is in the early stages of a
secular bull market and that the prices will continue to rise.

Reality

How can I say that when, "All the experts are saying otherwise"?
The question contains part of the answer. Experts are often
wrong. See "guru" above. But contrarianism is a small, empirical
phenomenon compared to the mechanical reasons supporting my
theory. Let me first start with the timetable.

$GOLD weekly (Stockcharts.com)

Notice that gold bottomed in early 2001 - eight months before the
9/11 attack and certainly before war with Iraq became a blip on
America's and the world's collective psyche. Clearly gold's rise
has little to do with war jitters in Iraq. Gold was rising before
most knew how to spell Iraq. That alone should tell us that the
mainstream media has it all wrong. But for the skeptics, let us
continue.

Second - and all else stems from this - The Fed, who can print
money at "virtually zero cost" per Fed Governor Bernanke, has
turned into a giant printing press, both paper and electronic,
which is flooding the market with the equivalent of Monopoly
money. The Dollar (an every other currency in the world, to be
fair) is only valuable because the specific country's central
bankers say it is valuable. The only currency that can ever hold
its value through the ages is gold. It will not take long before
foreigners and those at home realize that a decrease in scarcity
of currency, aka increase in supply, is a recipe for inflation and
they demand gold in place of a currency with inflated supply.
"Inflate or die", has to be the slogan of the century tacitly
implied by the Fed. Deflation is worse.

Third (we can hit these in nearly bullet point form from here on
out, as they flow from #2 above), there is less supply of gold
produced every year than is demanded. Demand outstrips supply.

Fourth, the U.S. trade deficit is explosive, which puts tremendous
pressure on the Dollar to devalue. We have counted on an infusion
of over $2 bln per day under the notion of keeping the Dollar
strong. Just how long will foreigners want to possess Dollars as
they devalue? Europe's Euro value has already risen 8% against
the Dollar this year.

Fifth, this brings up the idea of deflating currencies. With
other nations also teetering on recession, the only way to keep
their citizens employed is to make their goods cheaper to produce
than the next country's. That is accomplished by devaluation in
order to undercut your neighboring country's ability to sell
cheaper products compared to yours.

Remember Felix Zulauf from the January 30th Options 101? "Other
central banks will at some point then try to support the dollar,
because if it declines too much, it hurts their exports. They will
be forced to adopt the same policy as the U.S. central bank, and
you will have the whole world creating more fiat currencies. That's when gold will really run."

Zulauf goes on: "How far? In 2000, the ratio of an ounce of gold
compared to the Dow stocks was 45 to 1. It took 45 ounces of gold
to buy the Dow. Now, the ratio is down to 25 to 1."

Sixth, which reminds me, China's Yuan is tied to the Dollar, which
makes Chinese goods cheaper to produce as the Dollar declines in
value. Few will find it attractive to purchase goods other than
those from China. I might add here too that China bought over 1
mln ounces of gold in December. Are they doing this for fun? Not
on your life. They will buy on the sly. Remember, China set up a
gold exchange less than 18 months ago and is encouraging its
citizens to buy it.

As a point of historical fact, countries with gold as the standard
of currency have become great powers in the world. Those who
abandon it have eventually faded from glory. Not that I enjoy the
thought, but I'm thinking that our granddaughters may be doing eau
paire work in China 30-50 years from now. That ought to get some
hate mail!

Last, a mortgage debt bubble promises to slow the U. S. economy as
homeowners realize what they have done (borrow up to their
eyeballs) and begin to repay loans, thus foregoing the ravenous
consumer spending that has fueled the economy for years.

My point is that all this goes un-noticed or at least unreported
in the dominant financial media. Gold's ascent isn't just about a
war with Iraq, contrary to popular belief. It's an investor's
reckoning that the Fed printing press will render the Dollar worth
much less than it is now, and/or that China will export deflation
of goods to every producing nation on Earth. Either way, gold
wins - with or without war anywhere.

Frankly, this was not a pleasant piece to write today. But all of
the above reminded me why I felt compelled to get interested
preserving wealth in the first place. And the Fed is certainly
not there to HELP us preserve it.

That said, I increased my exposure to gold today through the
purchase of more CEF, as all the technical and fundamental
information available suggests it's a good trade while gold enjoys
the early stages of a bull market. I am pleased that few talking
heads believe that, which tells me gold has yet to be adopted as a
mainstream investment. I'll know it's time to sell when CNBC is
high-fiving the headiness of the whole thing and gold becomes the
social chatter at cocktail parties in much the same fashion as Dow
11,000 in February, 2000 was.

Between now and the time gold brings grins to the majority of
everyday investors, I will sleep well knowing my financial ark is
watertight and survivable if the economic storm worsens, and
others too begin to realize the importance of a financial ark.